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Telstra will have to reinject capital into Reach: analysts

Telstra Corp Ltd has virtually no choice but to inject more capital into its ailing Reach undersea cable joint venture, because it has committed 90 per cent of its international phone calls and internet connections to run through Reach's cables, according to analysts.

Telstra and its 50/50 joint venture partner in Reach, Hong Kong's Pacific Century CyberWorks (PCCW), have spent months in talks with a syndicate of banks that are owed $US1.2 billion from Reach.

Speculation has grown that Telstra and PCCW could soon announce the outcome of those talks, which analysts say could involve a Telstra investment of $300-500 million to help bail out Reach.

Another alternative is that Telstra and PCCW could decide to just walk away from Reach altogether and allow Reach to be re-claimed by the banks.

A sticking point is that Telstra has committed to buying a minimum of 90 per cent of its international capacity requirements from Reach "until the loan is repaid by Reach".

Telstra has already paid $US143 million ($A191 million) for that capacity.

The commitment was part of a deal Telstra and PCCW made with the banks last year to help reduce Reach's debt from $US1.5 billion to $US1.2 billion.

Credit Suisse First Boston analyst Guy Hallwright said the banks could force Telstra and PCCW to honour their commitments to use Reach's bandwidth if the telcos walk away.

"If (Telstra) walked away from Reach, presumably the banks would insist on the contract," he said.

It's unclear whether or not that would be the case.

"It depends on a lot of different things. I don't know what the banks are prepared to do," Mr Hallwright said.

If the banks don't insist on Telstra honouring its commitment, there would be no difficulties in Telstra getting the bandwidth from another provider.

However CommSec analyst Graeme Woodbridge said it would probably cost Telstra just as much as bailing Reach out.

"The issue is: does Telstra put some more money into Reach to keep it going or does it allow Reach to fold and then have to go and buy network capacity on other cables?" he said.

"Either way it seems that Telstra would have to pay out."

The Reach joint venture was started during the tech boom of 2000, but has since suffered from a global oversupply of undersea cables.

Reach's business is to provide bandwidth across Asia for telephones and the internet, and it has interests in more than 40 submarine cables.

But its poor performance led to Telstra last year making a $965 million writedown on the joint venture to zero.

"The only thing that stops this business from being insolvent is that the debts aren't due until 2010," one analyst said.
However there would still be some positives for Telstra in keeping Reach.

Citigroup Smith Barney analysts said it would preserve Telstra's relationships with the banks.

It would also allow Telstra to maintain ownership "of an asset with increasing strategic importance, given growing bandwidth requirements", Citigroup said in a report to clients.

Citigroup said it expected a settlement with the banks between 20-25 cents in the dollar plus working capital, totalling $300 million for Telstra.

Citigroup said it did not expect Telstra to write down the existing pre-payment.

However ABN-Amro's Justin Cameron suggested the pre-payment, of about $A191 million, would be written off.

Telstra would also be forced to provide capital support between $400-500 million, as well as make $264 million worth of debt repayments over the next few years, Mr Cameron said. in a report.

Telstra today reiterated its position that Reach has funding until the end of 2004.

"Reach is in discussion with the banks in relation to its loan facility," Telstra spokeswoman Kerrina Lawrence said.

"We can't provide any further update until the discussions are complete."

Telstra shares closed steady at $4.79. It was the top traded stock today with more than 45 million exchanged.